Escape from the Ivory Tower: Obscure Academic Economic Concepts Worth Knowing

Thanks. I’d never heard of that term before, but it’s helpful.

The trembling hand concept explains how one avoids settling into local minima. If the hand is “trembling,” it can jar you out of the local minima, allowing you to find the system minimum. It’s from systems theory (which also states that, in fact, equlibria are utter nonsense in a constatntly changing system).

Economists… this is otherwise known as simply a “stable equilibrium” from differential equations. Shorter and more informative name, and doesn’t make it sound like economists discovered it.

For example, there are two equilibria for a person to be at rest on a swingset — in the swing at the bottom and standing on top of the whole thing. One is stable because if you unintentionally jerk your head around when someone calls your name, you return right away to rest; the other is unstable because when you do this, your departure from rest grows and grows until you fall off.

The idea of an equilibrium that is stable to perturbations shouldn’t be obscure in econ. If it is, it explains a lot regarding why people worry about economists in their role as engineers:

Did you test this bridge to see if it’s stable to perturbations by the wind?

“Ummm, what’s thing you call ‘stable’?”

Quick everybody — get off that death bridge right away!

agnostic, precise mathematical translations of the notion of “stable” may be limited to infinitesimal perturbations (e.g., “Lyapunov stability”) or may accept infinitely large perturbations (e.g., “global minimum”). From my reading of Bryan Caplan’s original post, economists use “trembling hand stability” when they are referring not to either of those precise extremes, but to an intermediate property defined in terms of some imprecise plausibility cutoff: something like “stable within those finite perturbations which might plausibly happen by accident.” It’s often useful to consider that sort of stability, and I don’t know any universally accepted term for distinguishing it from infinitesimal or infinite perturbations. (I do know the somewhat-related terms “[chemical] activation energy” and “[a] boil the ocean [business strategy].”) I suspect if you pushed your bridge designer (or a control theorist, or a macromolecule chemist, or a population biologist) to express clearly his concern for stability under plausible perturbations, he’d consider it a relevant distinction, he’d either coin a phrase or come up with a phrase as field-specific as “trembling hands stability,” and he’d be likely to consider the economists’ “trembling hand stability” a fairly reasonable phrase.

My nominee is Baumol’s “unbalanced growth” (aka cost disease) concept. I see it everywhere but few economists I know seem to appreciate it.

I love Gresham’s Law.

Without fail, the physicists seem to think that economists are completely ignorant of mathematics. Trembling hand perfection is *entirely* unrelated to stability, in the Lyapunov or asymptotic sense. Indeed, trembling hand perfection is an equilibrium concept – it involves no dynamics at all! The principle reason to use thp is to eliminate “weakly dominated” strategies, or actions that are strictly worse or equal to some other strategy, but never better. Indeed, in a two player game, the concepts are equivalent. My reading of thp, though, it that it is most useful in dealing with uncertainty about the utility functions of other agents. That is, in the real world, I don’t know exactly how you map outcomes into utility, and so I should be “cautious”, in some sense.

In infinitely repeated games, we do have concepts like Lyapunov, but unsurprisingly, we call them Lyapunov stability.

The best “obscure” (though not to theorists, of course) economic theorems for me are the various information theorems due to Aumann and friends, which formalize precisely in what ways we can disagree, when trade can happen, etc.

“In infinitely repeated games, we do have concepts like Lyapunov, but unsurprisingly, we call them Lyapunov stability.”

OK, but both examples that Bryan gave for why the concept is enlightening involve more or less infinitely repeated games.

I.e., there’s a potential punisher and punishee, or a potentially late person and a person who potentially would scold them. There’s some kind of long-term supervision, formal or informal, of the one over the other. It’s at that long-term level that Bryan’s talking about not giving the minimal required effort or punishing small infractions, seems to me.

@Charlie,
The problem you’re talking about is known as the time-consistency problem, and the classical example is the government that says “people who build in a flood plain will not be eligible for flood assistance”. When the flood actually happens, the government’s incentive is to provide the assistance anyway. Everybody knows this, so the government’s original warning is not credible. This idea has been discussed in the context of monetary policy at least since the famous Kydland and Prescott paper (1984?).

Scott Sumner, on his Money Illusion blog, has discussed the idea that bailouts will always happen due to this problem. The only way to really prevent them is to have capital requirements and lending restrictions severe enough that banks never go bust.

Nate above identifies the problem with the post: the examples have little to do with trembling hand perfection.

Kudos to David in the second comment for bringing up evolutionarily stable strategies. More generally, there are many definitions of stability in games. Fortunately, they mostly predict the same outcomes.

In my experience running experimental games in the laboratory, stability is key. People almost never learn to play an unstable equilibrium in the lab, while they often learn to play a stable equilibrium if one exists. If there is no stable equilibrium, behavior in the lab never converges to any equilibrium.

If there are multiple stable equilibria–which there often are–trivial differences and simple random chance can determine which equilibrium gets played. I would put that fact high on the list of important esoteric facts. Most games have multiple equilibria, so economists who claim that such-and-such must happen because it is an equilibrium are overclaiming.

I always thought of the trembling hand perfect equilibrium as applying most conspicuously to mutually assured destruction.

How obscure does an economic concept have to be?

Bryan, you know how ignorant the average person is of economics — worse than ignorant, because they often “know” things which are actually false.

I’d say that the theory of comparative advantage would be really, really helpful for people to know. Ditto with rational ignorance and “the logic of collective action” and regulatory capture; and externalities and how to solve them (via Pigou and/or Coase).

$#!%, I’d be happy if the average person simply knew about the First Fundamental Theorem of Welfare Economics!